ONGC Risks First Loss on Oil as Discounts Climb: Corporate India

Oil & Natural Gas Corp. (ONGC), India’s
most-profitable company, is at risk of incurring a loss at its
crude oil business for the first time as subsidy payments and
production expenses rise.

The cost of producing crude oil has increased 5 percent,
while buyers are paying 4 percent less for the product,
squeezing margins, according to Chairman Sudhir Vasudeva. ONGC
may give 137 billion rupees ($2.2 billion) as discounts on its
crude oil sales to government-run refiners including Indian Oil
Corp. (IOCL) for the three months through Sept. 30, Vasudeva said.
That’s 11 percent higher than a year earlier.

“The narrowing margins at some point is going to affect
our growth, our capex, and our business,” Vasudeva, 59, said by
phone from New Delhi. “It’s difficult to sustain, difficult to
plan for the future.”

Pretax margins at ONGC, which is responsible for bolstering
India’s energy supplies, have already narrowed to a four-year
low as it gives away half of its profit to finance fuel
discounts mandated by the government. The erosion in earnings is
threatening to derail its plan to spend 11 trillion rupees by
2030 to raise output that is crucial to shrinking the nation’s
record current-account deficit.

Capping Prices

“If this rate of high subsidy payout continues, the
company will soon have to use its cash reserves for its capex
and operating expenses,” said Neelabh Sharma, analyst at BOB
Capital Markets. “If that becomes reality, it will be a
dreadful situation.”

Prime Minister Manmohan Singh’s government caps prices of
kerosene, diesel and cooking gas in a country where the World
Bank says about 820 million people live on less than $2 a day.
The subsidy burden is shared by the government and state-run
explorers as Singh struggles to rein in the second-fastest
inflation among the Group of 20 nations.

ONGC has gained 8.5 percent this year compared with a 9.1
percent rise in the benchmark S&P BSE Sensex (SENSEX) index. The shares
fell as much as 1.3 percent to 290 rupees and traded at 290.45
rupees as of 9:16 a.m. in Mumbai.

ONGC sold crude at $47.85 a barrel in the year ended March
31, less than the $54.72 in the previous year, according to a
Sept. 25 presentation on its website. This left the explorer
with a pretax margin at $7.75 a barrel, the lowest in at least
decade.

Narrowing Margin

The narrowing margin means oil accounted for 25 percent of
the explorer’s pretax profit in the year compared with about 55
percent of sales, Finance Director Aloke Kumar Banerjee said in
a Oct. 30 interview. The remainder of the profit was from the
sale of natural gas and products including naphtha and liquefied
petroleum gas.

The company will benefit from higher gas prices starting
April 1 next year. The government in June allowed producers to
set prices as a weighted average of rates in the U.S., U.K. and
import costs of Japan and India. This will almost double local
prices from the current $4.2 per million British thermal units.

“The higher prices will make the gas business more and
more relevant for ONGC,” said Gagan Dixit, a Mumbai-based
analyst with Quant Broking Pvt., who has a buy rating on ONGC.
“Anything above the current price will make a lot of smaller
and deepwater discoveries viable to produce from.”

ONGC sells its gas in dollars. The rupee’s 10.6 percent
decline this year helps it increase earnings when converted to
rupees.

Import Bill

India has spent $71.9 billion to import crude oil in the
six months to September, according to oil ministry data. That’s
31 percent of the nation’s total imports in the period. It’s oil
purchase bill climbed to a record $144 billion in the year ended
March 31.

The nation’s current account deficit rose to $21.8 billion
in the three months ended June 30 from $18.1 billion in the
preceding quarter after a record $31.9 billion in the previous
three months.

ONGC’s pretax margins, or profit before tax as a percentage
of sales, fell to 36.8 percent in the year ended March 31, the
lowest in four years. The measure for Cairn India Ltd. (CAIR), producer
of crude from the nation’s biggest field on land, was 74.5
percent.

Declining Output

Adding to the lower margins is ONGC’s declining oil
production. Output at its fields and that of its partners
dropped 3 percent to 26.12 million metric tons (522,400 barrels
a day) in the year ended March 31. Over 80 percent of the
explorer’s current output comes from fields that are more than
three decades old.

The explorer plans to spend 350 billion rupees in the year
ending March 31, Banerjee said. The company may have to use
about 50 billion rupees of its 132 billion rupees cash balance
to fund the expenditure, he said. Cash from operations dropped
to a three-low of 362 billion rupees in the last financial year,
according to data compiled by Bloomberg.

“In case existing subsidy regime continues, ONGC may
become cash surplus to cash deficit very soon,” the company
said in a Sept. 25 presentation on its website. “It will
constrain ONGC’s future investments in exploration and
production.”